Gloomy forecasts for a long UK recession by the Bank of England have renewed bets on a slide in the pound.
The currency is already heading for its worst year since 2008 and investors see little upside for sterling in coming months. Some are betting on another fall below US$1.10 by the end of the year, after it tumbled last week in the worst performance among major currencies.
The latest losses came as the central bank warned of a recession lasting to mid-2024. While policymakers delivered the biggest interest-rate increase in 33 years on Thursday (Nov 3), taking borrowing costs to a 14-year high of 3 per cent, they indicated economic concerns may make them more cautious going forward. That's a strong contrast to the Federal Reserve's hawkish message.
It means the yield differential with the US will keep widening, maintaining the pressure on the pound, said Joel Kruger, a market strategist at LMAX Group. The spread between two-year US and UK two-year government notes has already passed 160 basis points, its highest since 2019.
"The Bank of England has been forced into a near impossible balancing act of not tightening policy too much so as to exacerbate an already gloomy outlook for a struggling UK economy, while not keeping policy too loose so that inflation runs out of control and wreaks havoc from that front," Kruger said.
The next key catalyst for the pound is likely to be the government's budget due on Nov 17, less than two months after Liz Truss' proposals for unfunded tax cuts left investors reeling and sent sterling to an all-time low of US$1.035. The government replacing her has already warned of higher taxes as it tries to plug an "eye-watering" gap in Britain's public finances.
Here's a snapshot of what's happening across other UK markets:
The pound was the worst performer versus the US dollar out of a basket of major currencies by some margin, according to data collated by Bloomberg. Banks including Mitsubishi UFJ Financial Group, Deutsche Bank and Cooperatieve Rabobank are predicting a fall below US$1.10 soon.
Trading volumes in bond futures have collapsed since a recent peak in late September, pointing to a buyers' strike. That reflects uncertainty over where interest rates will end up, as well as a potential surge in bond sales in the coming months from both the BOE and government, according to Citigroup strategists. Traders are awaiting the budget to get a better grip on issuance.
The picture in the credit market is showing more signs of relief. A rally in medium-term, high-grade sterling company bonds means the spread no longer trades at a premium to equivalent US dollar notes, according to Bloomberg indexes. The spread has tumbled from the 150 basis-point peak reached on Oct 10, as Rishi Sunak's new government has bolstered investor perceptions of UK credibility.
The weak pound helped the FTSE 100 stock index, stacked with global exporters, to rally more than 4 per cent last week. Still, the more domestically-focused FTSE 250 has consistently underperformed its large cap peer this year. According to Goldman Sachs Group strategists, it's trading at the largest P/E discount against the MSCI World index since the dot-com period. That's "deserved given the weak outlook for UK growth, the level of GBP and the downside risks", they wrote in a note. BLOOMBERG